House of Representatives

Explanatory Memorandum

(Circulated by the authority of the Treasurer, the Hon Wayne Swan MP)

Chapter 4 - Application rules, transitional rules and consequential amendments for the new tax offsets

Outline of chapter

4.1 Schedule 4 to the Tax Laws Amendment (Research and Development) Bill 2010 (Bill) contains the application, savings and transitional provisions for the new research and development (R & D) tax offsets. These provisions:

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apply the new R & D provisions to work out an R & D tax offset for an assessment of income tax for an income year commencing on or after 1 July 2010;

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ensure that, despite the repeal of the existing R & D provisions, those R & D provisions can still apply, and be administered, for certain things done (for example, expenditure incurred) before the repeal of the existing provisions; and

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establish special transitional arrangements to broadly address some situations that straddle income years where the existing law and the new provisions apply.

4.2 Parts 2 to 6 of Schedule 3 to this Bill contain consequential amendments to the Income Tax Assessment Act 1997 (ITAA 1997), the Income Tax Assessment Act 1936 (ITAA 1936), the Income Tax (Transitional Provisions) Act 1997 (IT(TP) Act 1997) and the Taxation Administration Act 1953 (TAA 1953) that are necessitated by the enactment of the new R & D provisions.

4.3 In this chapter, legislative references are to the ITAA 1997, except where indicated.

Application, savings and transitional provisions

Application of new law

4.4 The main application rule is that new R & D provisions apply to work out an R & D tax offset for an assessment of income tax for an income year commencing on or after 1 July 2010. Consequently, the things eligible for a tax offset under the new provisions are:

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expenditure incurred in an income year commencing on or after 1 July 2010; and

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the use of depreciating assets in an income year commencing on or after 1 July 2010.

[Schedule 4, subitem 1(1)]

4.5 There are also supplementary application rules, consistent with the main rule, to ensure that for any things that do not affect an assessment, the new R & D provisions also apply to an income year commencing on or after 1 July 2010. [Schedule 4, subitem 1(1)]

4.6 The existing R & D provisions in sections 73B to 73Z of the ITAA 1936 are repealed. This change and other repeals in this Bill apply on the same basis as the inclusion of the new R & D provisions described above. Therefore, the existing R & D provisions apply to assessments for income years commencing before 1 July 2010. [Schedule 3, item 44 and Schedule 4, subitem 1(1)]

4.7 The general result that the application, savings and transitional provisions are designed to produce is that:

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the existing R & D provisions apply to expenditure incurred, and the use of depreciating assets, in an income year commencing before 1 July 2010; and

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the new provisions apply to expenditure incurred, and the use of depreciating assets, in an income year commencing on or after 1 July 2010.

Savings provisions

4.8 The Bill includes savings provisions to ensure that, despite the repeal of the existing R & D provisions, those R & D provisions can still apply, and be administered, for:

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any act done or omitted to be done (for example, expenditure incurred);

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any state of affairs existing;

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any period (for example, an income year) ending,

before the repeal of the existing provisions. [Schedule 4, item 2]

4.9 To this end, the Bill includes savings provisions to:

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prevent the making or amending of an assessment being affected by anything that is repealed or amended by this Bill, if the assessment relates to a period or event before the repeal or amendment;

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preserve powers, duties, rights and obligations in relation to the time before the repeal or amendment, if a right or obligation already existed before the repeal or amendment; and

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ensure that powers, duties, rights and obligations can still come into existence after the repeal or amendment if they relate to an earlier period or event. (For example, an eligible company may object under Part IVC of the TAA 1953 in an income year commencing on or after 1 July 2010 about a notice given under section 73IA of the ITAA 1936 for an income year commencing before 1 July 2010.)

[Schedule 4, subitem 3(1)]

4.10 The existing R & D provisions can also apply, even though repealed, where a state of affairs exists in an income year starting on or after 1 July 2010 in relation to a state of affairs existing, act done or period ending before the end of an income year starting before 1 July 2010. Examples of this include:

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an amount may be included in an eligible company's assessable income under subsection 73B(27A) of the ITAA 1936 for an income year commencing on or after 1 July 2010 if the company receives in that income year an amount for the results of R & D activities for which the company was entitled to deductions for R & D expenditure under section 73B of the ITAA 1936 in an income year commencing before 1 July 2010; and

•

an eligible company's deduction under section 73B of the ITAA 1936 for R & D expenditure incurred during an income year commencing before 1 July 2010 is reduced because of section 73C of that Act if, in an income year commencing on or after 1 July 2010, the company receives a recoupment of that expenditure from the Commonwealth.

The continued application of the existing provisions in these cases is consistent with the general approach that the existing law applies in relation to expenditure incurred in the income year starting before 1 July 2010. [Schedule 4, subitem 3(2)]

4.11 The above rules about assessments and powers, duties, rights and obligations specifically extend to the repeal of two provisions about an administrative penalty for failing to give details of an initial clawback amount (subsection 286-75(3) and paragraph 286-80(2)(b) of Schedule 1 to the TAA 1953). This has been done for the avoidance of doubt. [Schedule 4, subitem 3(3)]

4.12 As a matter of caution, savings rules have also been included to:

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preserve the effect of an assessment (for example, the evidentiary effect); and

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disregard the repeal of a provision for the purposes of another provision dependent on the repealed provision, as a precaution against the possibility that a repealed provision was an element in the operation of another provision that is still operative.

[Schedule 4, items 4 to 5]

4.13 Neither the existence nor the content of the savings provisions changes the scope or application of section 8 of the Acts Interpretation Act 1901 . That section provides, among other things, that the repeal of a provision does not affect its previous operation, the existence of any rights or liabilities it created or any investigation of, or penalties for, breaches of the provision. [Schedule 4, item 6]

Transitional provisions

4.14 In addition to the application and savings provisions, some special transitional arrangements are necessary. Broadly, these address some situations that straddle:

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one or more income years where the existing law applied; and

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one or more income years where the new law applies.

4.15 In this section, 'old law income year' means an income year commencing before 1 July 2010 and 'new law income year' means an income year commencing on or after 1 July 2010.

Depreciating assets

4.16 Under the existing law, an R & D deduction is allowed for decline in value of a tangible depreciating asset used for R & D activities. If that asset is also used for R & D activities in an income year starting on or after 1 July 2010, the new R & D provisions about notional deductions for the decline in value of R & D depreciating assts apply. Thus, tangible depreciating assets are eligible for the new rules, regardless of when they were acquired. To facilitate this, a number of special provisions are necessary to ensure that:

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the normal rules that limit the ability of an R & D entity to change the method of calculating decline in value apply [Schedule 4, item 10, section 40-67 of the IT(TP) Act 1997];

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a determination or calculation of effective life that was made under the existing law continues to apply [Schedule 4, item 11, section 40-105 of the IT(TP) Act 1997]; and

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an entity cannot allocate a depreciating asset to a low value pool or one of the small business pools after the existing R & D decline in value provisions have applied to the asset [Schedule 4, item 13, section 40-430 of the IT(TP) Act 1997].

4.17 There are also transitional balancing adjustment provisions to cover cases where:

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an R & D entity or an R & D partnership used a depreciating asset for R & D activities when the existing R & D provisions applied and when the new R & D provisions applied; and

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a balancing adjustment event happens in an income year starting on or after 1 July 2010.

Asset used only for R & D activities

4.18 If an asset used only by an R & D entity for R & D activities has a termination value less than its adjustable value, the entity is entitled to a notional deduction worked out under section 355-315 of the new law. In doing so, the use of the asset for the purpose of conducting R & D activities in old law income years is treated in the same way as the use of the asset for the purpose of conducting R & D activities in new law income years. [Schedule 4, item 15, section 355-320 of the IT(TP) Act 1997]

4.19 If the asset's termination value is greater than its adjustable value, an amount is included in assessable income under subsection 355-315(3) of the ITAA 1997. The calculation is similar to that where the asset is used only under the new law except that it takes into account that deductions under the old law were only uplifted by 25 per cent. For simplicity, deductions under the new law are treated as uplifted by one third (based on an offset rate of 40 per cent (rather the higher 45 per cent rate that generally applies to R & D entities with an aggregated turnover of less than $20 million). [Schedule 4, item 15, section 355-320 of the IT(TP) Act 1997]

4.20 There is a corresponding transitional balancing adjustment provision for R & D partnerships, which for individual partners allows a further notional R & D deduction or includes an amount in assessable income. [Schedule 4, item 15, section 355-325 of the IT(TP) Act 1997]

Assets used partly for R & D activities

4.21 If an asset used partly by an R & D entity for R & D activities has a termination value less than its adjustable value, the entity is entitled to a deduction worked out under section 40-292 of the ITAA 1997. In applying section 40-290 of the ITAA 1997, the use of the asset for the purpose of conducting R & D activities in old law income years is treated in the same way as the use of the asset for the purpose of conducting R & D activities in new law income years. [Schedule 4, item 12, section 40-292 of the IT(TP) Act 1997]

4.22 There is a corresponding transitional balancing adjustment provision for R & D partnerships, which for the partnership (not the individual partners) allows a deduction or includes an amount in assessable income. [Schedule 4, item 12, section 40-293 of the IT(TP) Act 1997]

Registration

4.23 In determining whether an entity qualifies for an R & D tax offset, it is necessary for a variety of provisions that the concept of registration also includes registration under the existing registration provisions. Those provisions include:

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section 355-205, which allows a notional deduction for R & D expenditure; and

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section 43-35, which allows an actual deduction for building works used for R & D activities.

[Schedule 4, item 15, section 355-200 of the IT(TP) Act 1997]

Prepayments of R & D expenditure

4.24 The existing law has specific rules for expenditure defined as 'advance R & D expenditure' under subsection 73B(1) of the ITAA 1936. Those specific rules broadly spread the amount of a deduction over a number of income years where expenditure is incurred to a registered research agency for services to be provided over a period of 13 months. A special transitional rule will ensure that the existing law continues to apply to that expenditure actually incurred in an income year starting before 1 July 2010 but taken by subsection 73B(11) to be incurred in an income year starting on or after 1 July 2010. To ensure this result, registration under the new registration rules is taken into account. [Schedule 4, item 15, section 355-550 of the IT(TP) Act 1997]

Expenditure reduced to reflect group mark-ups

4.25 A transitional rule ensures that for the purposes of the integrity rule about intra-group mark-ups (section 355-415), the calculation of any reduction in the amount of the notional deduction disregards any amount that has already been taken into account under the corresponding rule in the existing law. [Schedule 4, item 15, section 355-415 of the IT(TP) Act 1997]

Undeducted core technology expenditure

4.26 As explained in Chapter 3 (in paragraphs 3.64 to 3.66 and 3.69) the special treatment of core technology expenditure under the existing law is to cease and normal income tax treatment is to apply. Special transitional arrangements will ensure that any undeducted core technology expenditure is eligible for deduction.

4.27 If the core technology is a depreciating asset (for example, a patent), the provisions for deducting amounts for depreciating asset will apply on the basis that the opening adjustable amount is the amount of undeducted expenditure in relation to the asset. [Schedule 4, item 15, sections 355-600 and 355-605 of the IT(TP) Act 1997]

4.28 If any core technology is not a depreciating asset, the undeducted expenditure is deductible in equal proportions over five income years, starting in the first income year commencing on or after 1 July 2010. This is somewhat similar to the treatment of certain business capital expenditure that is not otherwise taken into account (under section 40-880 of the ITAA 1997). [Schedule 4, item 15, sections 355-600 and 355-610 of the IT(TP) Act 1997]

Consequential amendments

4.29 Some amendments to provisions of the income tax law outside the new R & D provisions (in Division 355) are explained in Chapter 3 because they are important to the overall operation of the new R & D tax incentive. Examples include the amendments to the tax offset rules and to the depreciating asset rules in relation to their use for R & D activities.

4.30 This chapter explains the other consequential amendments.

Prepayments of expenditure for services

4.31 As discussed in Chapter 3 under the heading 'R & D deductions are notional only' in paragraphs 3.43 to 3.46, the deductions under Division 355 are treated as actual deductions for the purposes of the rules about the period of deductibility of certain advance expenditure (in Subdivision H of Division 3 of Part III of the ITAA 1936).

4.32 To ensure that the advance expenditure provisions can apply to the new R & D provisions in a similar way that they apply to the expenditure under the existing R & D provisions, the Bill makes a series of amendments to the advance expenditure provisions. These involve changes in section references and terminology to those used in the new law. [Schedule 3, items 6 to 14, sections 82KZL, 82KZM, 82KZMA, 82KZME and 82KZMF of the ITAA 1936]

4.33 The advance expenditure provisions are also amended to ensure that they can apply to R & D expenditure deductible under section 355-205 where that expenditure is capital. There is no sound reason to exclude capital expenditure that is deductible under the R & D provisions. Indeed, an additional reason why the advance expenditure provisions should apply is that capital expenditure would not be immediately deducted under ordinary tax principles. [Schedule 3, item 5, definition of ' excluded expenditure' in subsection 82KZL(1) of the ITAA 1936]

Recoupment of deductible expenditure

4.34 As explained in Chapter 3 under the heading 'R & D deductions are notional only' in paragraphs 3.43 to 3.46, the deductions under Division 355 are treated as actual deductions for the purposes of the rules about recoupment of deductible expenses in Subdivision 20-A.

4.35 The recoupment provisions in Subdivision 20-A are also amended so that they can apply generally to the recoupment of amounts deductible under the R & D provisions in Division 355. Without the amendment, Subdivision 20-A would apply only where the recoupment was by way of insurance or indemnity. [Schedule 3, items 69 and 70, section 20-30]

4.36 The recoupment provisions in Subdivision 20-A can only include an amount in assessable income up to the amount received by the taxpayer as recoupment. The proposed claw back provisions (discussed above) can recover the enhanced benefit received by a taxpayer but are limited to where the recoupment (or grant) is from an Australian government agency. So, where a recoupment is received other than from an Australian government agency, provisions are needed to ensure that the taxpayer has not obtained a benefit where it has incurred no net expenditure.

Capital works

4.37 The capital works provisions in Division 43 are amended to:

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replace references to the existing R & D provisions with references to the new R & D provisions; and

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reflect the terminology used in the new provisions.

[Schedule 3, items 26 to 41, sections 43-35, 43-70, 43-90, 43-100, 43-140, 43-195, 43-210 and 43-215]

Capital gains and losses

4.38 As explained under the heading 'R & D deductions are notional only' in paragraphs 3.43 to 3.46, notional R & D deductions are treated as actual deductions for the cost base rules in the capital gains and losses provisions (commonly known as capital gains tax (CGT)). Consequently, the existing provisions that exclude certain deductible expenditure from the cost base or reduced cost base of a CGT asset apply to expenditure that is notionally deductible under the new R & D provisions.

4.39 There are consequential amendments to the CGT provisions to:

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replace references to the existing R & D provisions with references to the new R & D provisions; and

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reflect the terminology used in the new provisions.

[Schedule 3, items 73 to 90, sections 104-235, 104-240, 108-55, 110-45, 118-24 and 118-35]

Definitions

4.40 The amendments to the taxation law discussed in this chapter have necessitated the inclusion of various new definitions in the Dictionary in the ITAA 1997 (and the repeal or amendment of some others). The substantive effects of these changes are discussed in Chapter 3. [Schedule 1, items 2 to 10, subsection 995-1(1)]

Checklists

4.41 The amendments to the taxation law have necessitated the amendment of various checklists in the ITAA 1997. [Schedule 3, items 56 to 68, sections 9-5, 10-5, 12-5, 13-1 and 20-5]

Other consequential amendments

4.42 There are also consequential amendments to various other provisions of the tax law to:

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replace references to the existing R & D provisions with references to the new R & D provisions;

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reflect the terminology used in the new provisions; and

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reflect the repeal of various existing R & D provisions, where there are no corresponding new provisions.

[Schedule 3, items 49 to 53, 71, 72, 96 to 98, 100 to 111]